Should I delay taking social security?

I understand that if I delay taking Social Security, I'll receive a larger benefit. But while I'm waiting for that bigger benefit, I'll have to withdraw more from my retirement savings, which means I'll miss out on the investment gains those larger withdrawals would have earned. Given those lost investment earnings, am I really better off by waiting for a bigger Social Security check? --M.A.

It's true that if you retire but wait to take Social Security to qualify for a bigger monthly check down the road, you'll have to replace the income you would have received from Social Security had you taken it right away. Which means you'll have to draw more from savings. So initially at least, the value of your nest egg will decline faster than it otherwise would have due to those larger withdrawals.

But while waiting for a bigger Social Security check will indeed result in a loss of investment earnings potential on your savings in the short-run, remember that you'll be able to reduce the withdrawals from your nest egg when those bigger Social Security payments kick in.

So to gauge the effect on the value of your savings by starting Social Security early rather than later, you have to take a longer view. And you have to consider what you think you can reasonably earn on your retirement assets as well as how long you might live.

Here's an example: Let's assume you plan to retire at 62, at which point you qualify for a Social Security benefit of $1,500 a month, or $18,000 a year, an amount that will increase with inflation each year. And let's further assume that you have $750,000 in savings from which you plan to withdraw an initial 4%, or $30,000, a figure you'll also increase by the inflation rate each year. If you go through with this plan, you'll have annual income of $48,000 ($18,000 in Social Security plus $30,000 from your nest egg) that will rise with inflation to help maintain your purchasing power throughout retirement.

Or, you could choose to postpone Social Security in order to qualify for a bigger benefit later on. Generally, your Social Security benefit rises by roughly 7% to 8% for each year you delay between age 62 and 70, after which you receive no increase for waiting. So if you hold off claiming benefits for four years until age 66 -- the full retirement age for people born between 1943 and 1954 -- you would receive $2,000 a month in today's dollars, or $24,000 a year, which is a third more than what you would get at 62.

But if you decide to hold off for a higher benefit and still want to match the $48,000 in annual inflation-adjusted income above, you would have to get that entire amount from your savings for the four years until you begin collecting that higher Social Security benefit.

There's no doubt that, initially at least, your nest egg will be smaller and thus have less potential to generate investment earnings if you opt to wait for the larger Social Security benefit. After all, you'll be withdrawing $48,000 a year adjusted for inflation instead of $30,000. But after four years, the withdrawals from savings required to hit your annual income target will drop off by roughly half when your higher Social Security benefit kicks in. And at that point and every year afterward, you'll be withdrawing about 20% a year less than what you would withdraw from savings with the lower Social Security benefit.

So the question is, if you opt to wait for the higher Social Security benefit, how long would it take until the lower withdrawals that start after four years of retirement and continue afterward allow the value of your nest egg to recover and eventually exceed what its value would be had you opted for the lower Social Security benefit that started sooner? Or, to put it another way, how many years does it take for you to come out ahead by waiting for a higher Social Security benefit?

The answer depends in large part on how much you think you can earn on your retirement investments after inflation. Basically, the higher the real, or inflation-adjusted return, you earn, the longer it takes to come out ahead waiting for the higher Social Security benefit.

For example, if inflation cruises along at roughly 2% or so a year and your investments earn 6% -- a real, or inflation-adjusted, return of about 4% -- it would take until age 83 or so for you to come out ahead by opting for the larger Social Security benefit. In other words, you'll end up with the same retirement income plus a larger nest egg as long as you make it to age 83. If, on the other hand, inflation runs at 2% but you earn, say, 7% on your retirement investments -- a real return of about 5% -- it would take another few years, until age 86, for the higher Social Security benefit option to pay off.

Of course, you could delay taking benefits even longer in hopes of a still higher Social Security payment. In the scenario above, for example, waiting until age 70 to collect rather than age 66 would result in a benefit in today's dollars of $31,680, compared with $24,000 at 66. But holding off from age 66 to age 70 would require more years for you to come out ahead. Assuming an annual real rate of return of 3% to 5%, you would have to live until your mid-to-late 80s to early 90s to be better off waiting for the higher benefit.

Given those ages, does it make sense to hold off for a higher Social Security benefit if doing so might leave you with a smaller nest egg unless you live into your early-to-late 80s? Obviously, that depends a lot on the state of your health and whether you come from a family that has a history of long lifespans. But generally people nearing or entering retirement in decent health have a pretty good shot at living into their mid-80s and beyond.

For example, a 62-year-old man in average health has a 53% chance of living to 85, a 34% chance of making it to age 90 and a 26% shot at making it to age 92, while a 62-year-old woman's chances are 64%, 46% and 37% respectively. The chances are significantly higher for 62-year-olds in excellent health. You can see your chances of making it to various ages based on your current age, sex and how healthy you are by going to the American Academy of Actuaries' and Society of Actuaries' Longevity Illustrator tool.

A few caveats: Postponing Social Security probably isn't a good idea if poor health is likely to shorten your life expectancy (although it can still make sense if your spouse will be depending on your benefit after you die).

Delaying also may not be a smart move if doing so would cause you to deplete all or virtually all of your retirement savings, leaving you with no savings to fall back on for unanticipated expenses and emergencies. (If that's the case, however, you may not have adequate savings to retire and thus should consider working longer to bulk up the size of your nest egg.)

I'd also caution against overconfidence when it comes to investing. I get lots of emails from people who tell me they're better off taking Social Security early and investing it rather than waiting for a larger benefit because they're confident they can earn a high rate of return. People can disagree about what constitutes a realistic rate of return for someone in retirement. But given today's low yields and predictions of modest returns in the years ahead, I'd say that a real return of 3% to 4% a year—that is, the return in excess of inflation—is probably reasonable for most retirees. You can shoot for higher gains, but doing so inevitably means taking on more volatility, which raises the possibility that your nest egg could be so decimated by a severe market setback that it might never completely recover.

Or you may want to consult a financial planner who can also factor the effect of income taxes into the analysis (which, to keep things relatively simple, I didn't do in the examples above).

But the bottom line is this: If you can manage it, you're generally better taking Social Security later rather than sooner, as a higher benefit that's pegged to inflation acts as a form of longevity insurance that can help you maintain your standard of living throughout retirement, regardless of how the financial markets and your retirement investments perform.